Tax Memorandum # 2 - Memorandum To: Mr. Kim From: Maria E....

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Memorandum To: Mr. Kim From: Maria E. Breijo Date :08/17/2010 RE: Tax Memo #2/ Executive Compensation Issues stated Mr. Kim is the sole shareholder and CEO of KimTech, Inc., a technology company valued at approximately $5,000,000. KimTech is a C corporation for federal tax purposes. In 2007, KimTech had net pretax profits--before deducting Kim's compensation--of $1,000,000. After deducting Kim's base salary of $100,000 and bonus of $800,000, the company was left with a small after-tax profit, which was retained by KimTech (i.e., no dividends were paid to Kim). KimTech has two other officers, a CFO and a VP of Sales and Marketing, each of whom received salaries of $100,000 and no bonuses. Kim's bonus was awarded by the board of directors, which consists of three directors: Kim, who serves as Chairman, the CFO and the VP of Sales and Marketing. In determining Kim's bonus, the board multiplied pretax profits, before Kim's compensation, by 80% (i.e., $1,000,000 x .8 = $800,000 bonus). In recent years, KimTech's value has been appreciating at 7% per year. Assume that the average compensation for CEOs of similar-sized companies in the same industry is $500,000 (salary and bonus combined). Assuming that 2007 is a typical year for KimTech, in terms of profitability and compensation practices, evaluate the reasonableness of Kim's compensation package in light of the five factors enumerated in the Elliott’s case. If audited by the IRS, will Kim's compensation be deemed reasonable? Why or why not? What can KimTech do to show that Kim's compensation is reasonable? Assuming that 2007 is a typical year for KimTech, in terms of profitability and compensation practices, evaluate the reasonableness of Kim's compensation using the independent investor/return on equity approach. Is Kim's compensation package reasonable under this test? Why or why not?
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Tax Memorandum # 2 - Memorandum To: Mr. Kim From: Maria E....

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